Why is Dave Ramsey Hating on Northwestern Mutual?

Today, I’d like to respond to a clip from Dave Ramsey’s television show on Fox Business where he talks about life insurance as being “terrible” and how buying term and investing the difference is a better strategy than using any type of cash value life insurance. Just to clarify before I begin, I agree with lots of what Dave Ramsey has to say about getting out of debt, cutting up credit cards, and putting a stop to out-of-control consumerism.

httpv://www.youtube.com/watch?v=3b-q8MLfH2w

But, when it comes to life insurance, he’s dead wrong. In my response, I’m particularly going to focus on his attack of cash value life insurance.

Hold Your Horses, Dave

His first misconception about cash value life insurance is that it’s a terrible cash accumulation tool. Of course, I absolutely agree with Dave Ramsey’s view of the way most agents structure cash value life insurance. When directed by an incompetent or unscrupulous agent (both are equally bad), cash value life insurance naturally stinks as a tool for accumulating cash.

That’s why it’s important to work with a professional that knows what they’re doing. Otherwise, cash value life insurance is a terrible place to put your money. However, with the guidance of the few of us who both know how and choose to structure these policies properly, there can be huge benefits of the cash accumulating variety.

A few important basics to always keep in mind:

1. Remember money inside a cash value life grows tax deferred according to section 72e of the IRC.

2. The death benefit is paid out income tax free according to section 101a of the IRC.

3. And section 7702 of the IRC explains how the value inside a policy can be accessed without a tax consequence. That potentially tax free income can make a huge difference in your retirement plans, especially if you think tax rates increase in the future.

So, what do you think…are taxes going up, down or likely to stay the same in the future?

In light of the rising deficits, among other things, I think it’s safe to say taxes can’t go anywhere but up. If we take the numbers Dave Ramsey uses in a common example, a 32-year-old male who’s making 40k per year should be using 15% of his income to buy term life insurance and mutual funds.

Dave says growth stock mutual funds are the right investment for all of the money you would be using on a cash value life insurance policy. This is the classic buy term, invest the difference advice.

In other words, buy a really cheap term life insurance policy, take the difference of what you would have spent on the cash value policy, and plow it into growth stock mutual funds.

By the way, he always recommends you buy 10x your income in life insurance death benefit.

Does this sound familiar? If not, watch a little of this video to get a taste (skip ahead to 5:21; that’s where it gets really good).

Sound familiar? If not, watch a little of this video to get a taste (skip ahead to 5:21, that's where it gets really good)

httpv://www.youtube.com/watch?v=-u-E91lNkrE

The idea is that in 20 years, when the term policy runs out, the money accumulating in the growth stock mutual funds will have outpaced the death benefit, and therefore, the death benefit will no longer be needed.

On the flip side, Dave proposes that funding a cash value life insurance policy with that money is a horrific mistake. In classic Insurance Pro Blog fashion, I intend to argue that point with the help of some numbers. As far as we’re concerned, all talk and no facts equal a whole lot of nothing.

Let’s compare the two strategies and the shortcomings with an example.

Tom is a father, 32 years old with two children and an income of $40,000 per year. Using Dave’s math, we’ll take $6,000 (15% of his gross income) for the retirement plan. According to Term4Sale.com, Tom could purchase a $400,000 20-year term insurance policy at a cost of about $217 per year if he’s in perfect health and doesn’t use any sort of tobacco products.

That leaves Tom with $5,783 to invest into growth stock mutual funds. We’ll assume that he earns an 8.0% rate of return over that time frame. Yes, this rate of return is much less than the 10% that Dave Ramsey often talks about, but given recent history, I think that 8.0% is more realistic (in fact, we prefer to use something like 6% when we help our clients plan for the future).

If I look at the investing calculator over at Dave Ramsey’s website, it tells me that Tom should have $285,753.12 (this is the gross number) after investing $5,783 per year for 20 years.

Note: Other things that should be taken into consideration are taxes and costs but his calculator doesn’t provide those options. With mutual funds you will have both to consider. Now, tax rates are difficult to nail down but let’s just use a 15% federal tax rate because with Tom’s income and having two kids, that’s probably not that far off.

If I look at the investing calculator over at Dave Ramsey’s website, it tells me that Tom should have $285,753.12 (this is the gross number) after investing $5,783 per year for 20 years.

Sorry To Burst Your Bubble, But….

Prudent financial planning isn’t based on a set of unrealistic rules. For one thing, assuming an 8% rate of return when helping a young guy like Tom plan for his future is just plain irresponsible. What if he doesn’t hit 8%? After 20 years, it’s too late to go back and put more money away. The genie’s out of the bottle at that point.

As Brandon and I have stated many times, chasing investment returns is a poor solution for not having saved enough. Plus, after 20 years, Tom is 52 years old and has no life insurance under Dave Ramsey’s model.

How many people do you know at 52 who have no need for life insurance?

I’ve been in this industry for 13 years, and I’ve only met a handful of people who were in that position at 52. What’s more is that none of them made $40,000 a year.

Please don’t misunderstand me. Term insurance is a valuable tool, and most people like Tom should own more of it. But, the reality is that most people’s lives don’t move in a straight line from point A to point B, a reality that the buy term, invest the difference crowd seems to ignore.

Back To The Numbers

If Tom were to use a policy structured correctly – the way we do for our clients – he would pay a premium of $6,000 annually, which would buy a death benefit of $400,000. In 20 years, he could request that the policy be “reduced paid-up,” and his death benefit would be $558,488 with a cash value of $213,895.

While it’s true that the cash value isn’t as much as the $285,753.12 he would hypothetically have if he invested the difference and managed to net 8% compounded, he can take his insurance cash value income without a tax consequence if it’s executed properly. Also, if he chooses to leave the cash value alone, it will continue to grow, and his policy will continue to earn dividends.

Does that seem like a fair exchange of value to you?

It does to me. This is the power of cash value life insurance properly executed by an agent who cares about what’s best for the client.

If you’re interested in learning more of how this works and how it might benefit your situation, get in touch with us.

Brantley is a practicing life insurance agent and has been for nearly 18 years. After years of trying to sell like his sales managers wanted him to, he discovered that people want to buy life insurance if you actually explain the benefits.